by Bryan Perry
February 28, 2023
Based on the recent string of economic data, which includes January employment, inflation (CPI, PPI, and PCE), weekly initial jobless claims, personal spending, and consumer confidence, it appears that the domestic economy is functioning fairly well against a backdrop of some very stubborn inflationary forces.
The annual U.S. inflation rate is 6.4% for the 12 months ending January 2023, according to U.S. Labor Department data published February 14. The next inflation update is scheduled for release on March 14.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Inflation is coming down, but not nearly fast enough to please the Fed. Markets now expect three more quarter-point rate hikes – extending to the July meeting. Depending on upcoming employment totals, plus inflation and other economic data, all to be released before the March 22 FOMC meeting – investors are starting to see a growing chance of a 50-basis-point move at that meeting, which would imply a total of 100 basis points from now through July. This latter scenario would take Fed Funds up to 5.50%-5.75%.
While the prospect of “higher-for-longer” interest rates has been on the investor’s mind for some time, it’s taken a while for the reality of such a scenario to sink in, and last week’s price action for both the bond market and stock market started to reflect this reality. Even with all the attention that a potential half-point hike at the March meeting is getting, the FedWatch Tool puts only a 27% chance of that happening, and a nearly 73% probability of a quarter-point hike being the most likely outcome. But again, investors will receive a parade of fresh data that will make this decision more firm in the next two weeks.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
As it stands, the assumption of a rapid deceleration of inflation that unfolded in January – which fueled that month’s rally – has stalled, so we have now entered a market of value realization, where the narrative of the Fed being tighter for longer has taken hold of investor sentiment. How the market responds to this change is evidenced by the 5.2% retracement by the S&P 500 to its 200-day moving average.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The angst over last Friday’s PCE report was that it showed how robust spending will keep the economy moving ahead – despite inflation – at a pace that will keep inflation at elevated levels for some time.
Even with an unexpected 1.8% jump in the personal spending rate for January, the personal savings rate as a percentage of disposable income increased to 4.7% from 4.5% in December.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It was broadly thought that the consumer was somewhat tapped out, but within the data, spending was notable in purchases of cars, appliances, hotel stays, and going out to restaurants. The bump in the savings rate at the same time as the spike in spending runs counter to the narrative coming into February, amidst rising bond yields and borrowing costs. Prior to the Great Recession of 2008-2009, before quantitative easing became embedded in Fed policy for most of the next 14 years, the rate of inflation was running at closer to 3% than the Fed’s target of 2%. From the Fed’s birth in 1914 until 2023, the CPI averaged 3.28%, reaching an all-time high of 23.7% in June of 1920 and a record low of -15.8% in June of 1921.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Here is where it gets interesting for market participants. With salaries and hourly wages having risen, and the labor force participation rate still below pre-pandemic levels, one could argue that labor inflation is going to remain high. As far as the shelter component is concerned, new home construction fell again in January, the fifth straight monthly decline, adding to the longstanding inventory problem. Tight inventory has kept prices from dropping off substantially, making homes still unaffordable for many, especially first-time homebuyers. Those that locked in super low rates for buying or refinancing are staying put.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It seems plausible that if the annual rate of inflation can get back down to the historical 3.3% level, the market should be elated. The timeline in which this scenario could unfold has obviously been pushed out by both the Fed and market participants, so it appears that the Fed’s target rate of 2% is wholly unrealistic this year, especially with the risk of a more protracted war in Ukraine and the potential for new actions by the U.S. and China. The notion of a sub-3% inflationary Eden materializing anytime soon has been tabled.
To this end, investors that demand yield can look at a variety of choices, depending on risk tolerance, starting with short-term Treasuries. As of last Friday, a one-year Treasury Bill was paying 5.07%. For those willing to take on risk, hard asset lenders, bridge financing, and business development companies are paying 6%-12% depending on the portfolio composition of leverage and exposure to floating rate securities. In the energy patch, closed-end funds that own MLPs are paying upwards of 8%-9% with no K-1s issued.
At some point, when the Fed has reached whatever level becomes the terminal rate, it will present an excellent opportunity to lock in long-term rates on bonds and some zero-coupon Treasuries that will vault higher in value when rates recede. Right now, the bond futures market thinks that time will be in July.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
If so, this traditional bell curve strategy might come right back into fashion.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
“Seasonal Adjustments” Continue to Warp Key Statistics
Income Mail by Bryan Perry
The Fed Should Adjust Its Inflation Target to the 3.3% Historical Average
Growth Mail by Gary Alexander
Good News: Two Great Market Months Start Tomorrow
Global Mail by Ivan Martchev
The Stock Market is Not Ready for 10-Year Treasury Rates Above 4%
Sector Spotlight by Jason Bodner
What’s Behind the Latest Selling? Is It the “News” or Big Traders?
View Full Archive
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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